Virtually everyone has noticed the price of WTI oil fell dramatically since June 2014. Many in the US and elsewhere have been very happy to see the price of gasoline and other fuels decline considerably in the last seven months. Many have touted the positive effects the monies not spent on gasoline may have on the US economy. They believe such monies will be spent elsewhere; and that will supposedly stimulate the US economy. However, there may be significant flaws in that logic.
First the US will lose all of the revenues it derived from the higher price of oil. WTI oil prices fell from $107.68 per barrel on June 13, 2014 to a low so far of $53.60 on December 18, 2014. They closed on December 26, 2014 at $54.73 per barrel. This is more than -$50 per barrel below the June 2014 high. In November 2014, the US produced about 9 million bopd. Over a one year period the loss of about -$50 per barrel of oil revenues would amount to 9,000,000 bopd * 365 days * $50/barrel = $164.25B. For 2015 this number will be a little higher as production is expected to average 9.3 million bopd (so -$169.7B). This amounts to approximately -1% of the US GDP by itself. When you add in all of the losses due to the price falls of all the finished petroleum products, the number becomes much larger. For instance, the average price of US gasoline in December 2013 for regular unleaded was $3.268/gallon. The average price this December (2014) is $2.324/gallon. That is a 28.9% drop.
As a ballpark figure I will estimate that other finished petroleum products suffered like drops. Roughly this means that the 19.1 million bopd expected to be consumed in the US in 2015 translate into 42 gallons/barrel * 19.1 million bopd = 802.2 million gallons per day. 8.86 million of the bopd will actually be gasoline consumed; but I will just approximate losses by treating it all as gasoline. Distillate fuel oil (4.03 million bopd) and jet fuel (1.46 million bopd) are among the larger other components of US petroleum finished products consumption. The US is a net exporter of finished petroleum products by about 2 million bopd, so essentially all US finished petroleum products production is homegrown. If the US is averaging -$0.944/gallon less in revenues, this amounts to 802.2 million gallons per day * $0.944 = $757.28 million per day. Over a full year this amounts to $276.41B in lost revenues to US industries; and that does not even take into account the economic multiplier effect of such revenues being spent again within the US economy. Hence the total almost direct loss to the US economy of the -$50/barrel in oil price (and the finished petroleum products price losses) is about -$441B.
According to TradingEconomics the US GDP for 2014 is estimated at $16.8T. $441B is about -2.6% of the US GDP. That is a lot of revenue to lose. Some point out that the revenue not spent on oil, gasoline, and other finished petroleum products will then be available to be spent on other US goods and services. The problem with that rational is that a lot of those monies would have been available to be spent again (the multiplier effect) on other US goods and services after they were originally spent on oil and finished petroleum products. For instance, oil company salaries are usually re-spent on other goods and services.
As a result of the dramatic oil price drop, oil companies are cutting back on their CapEx plans for 2015. For oil and gas E&P companies, CapEx expenses are mostly drilling and completion expenses. Cuts to CapEx mean that there will be a lot less drilling and completion work done in FY2015. As an example, Continental Resources (CLR), a large US unconventional oil and gas developer, cut its $5.2B CapEx budget for FY2015 to $4.6B last month; and it recently cut it further to $2.7B this month (December 2014). This is about a 48% cut to the FY2015 CapEx budget. Since a small amount of the CapEx isn't for drilling and completion activity, one might say CLR is now planning to do 50% less drilling and completion work in FY2015. This will cut CLR's growth immensely. It will also negatively impact any oil services companies CLR employs. Those companies will receive billions less in revenues in FY2015; and they in turn will cut their purchases from still other companies such as US Steel (X), which supplies the steel tubing used in drilling. All of these companies will lay off employees, since less work will be being done. Those laid off will in turn spend less money on other US goods and services such as food, clothes, rent, etc. It is easy to see this negative pattern.
Of course, many will argue that the monies not spent on oil will be spent on things other than oil products. There are a few problems with this. First most people need gasoline to get to work, to go shopping, to transport the kids, etc. It is a necessity. More food, more clothes, etc. that the monies could alternatively be used for may not be nearly as essential. This probably means that people will pay off credit cards more. Perhaps they will save more. While these are good things, they do not tend to make economies grow as quickly. They tend to decrease the velocity of money; and hence they tend to decrease the money supply, especially if banks are hesitant to over lend when the world economy seems to be generally weakening. In sum less of the monies overall would be spent immediately. Plus the multiplier effect would likely be a lower multiple. That may mean that the US economy may lose -1% to -2.6% in GDP just from oil price cuts alone.
Admittedly some companies should benefit. Airlines such as United Continental Holdings (UAL), American Airlines Group (AAL), and Southwest Airlines (LUV) should see cost benefits to lower fuel prices. The same is probably true for delivery companies such as FedEx (FDX) and United Parcel Service (UPS). Manufacturers that use delivery services a lot should see lower delivery costs. One might think this last would make their products more competitive. However, even this may not be true. The delivery fuel costs for foreign products are much higher. Therefore cuts to fuel costs should help them reduce their prices disproportionately more compared to US manufacturing companies selling in the US. This might have the effect of making US companies less competitive in the US and even worldwide. That in turn would lead to a decrease in US GDP growth.
Another supposed positive that may be less so is the decrease in the oil trade deficit due to the large decrease in oil prices worldwide. This will likely help the USD gain against other currencies because it should decrease the outflow of monies from the US economy. In other words it should cut down the rate of growth of debt to foreign countries due to oil. That should lead to a stronger USD. Unfortunately a stronger USD will negatively impact US exports. That in turn will tend to slow the US economy. Further the stronger USD will tend to make foreign products cheaper for US consumers. This will make foreign products sell better against US products. It may mean an overall increase in foreign imports in other areas that may be hard to reverse once oil prices rise again. It may lead to the loss of more US jobs to foreign businesses. This again should result in lower US GDP growth.
The BOJ currently has a huge QE program in place. The ECB has announced that it wants to have a €1 trillion QE program in 2015. Thus far Germany has not agreed to it; but a recent Bloomberg survey reported that 90% of the economists surveyed believed that Germany would eventually agree to Draghi's plan. Since Germany's economy has been troubled lately itself, the economists are likely right. These QE programs will in turn likely lead to an even stronger USD. That will lead to lower US exports; and it will likely lead to even lower oil prices for the US. We may not have seen the bottom in oil yet, although we are likely close to a bottom. The bottom may come after the ECB's QE program is finally approved and started. The consequently lower oil prices may put even further pressure on the US economy.
It may be impossible to estimate exactly how much of a negative effect lower oil prices will have on the US economy. However, this article should make it reasonably clear that lower US oil prices are unlikely to be a positive for the US economy. If prices had only fallen to $80-$90/barrel level, then the CapEx estimates for oil companies and oil services companies would have been much less affected. The economic damage would have been much less. However, as few people seem to realize, dramatic changes tend to cause dramatic damage to industries. Such damages are not as easily repaired as the damages from smaller downward moves. The US and US citizens should prepare for some uglier than expected times ahead. Just how bad those times will be will depend on many other factors. A lot of these are unpredictable at the present time. Central banks and national governments may exert some control. Still investors should be aware of the possibilities and likelihoods.
The chart of the SPDR S&P 500 ETF (SPY) provides some technical information about the state of the general market.
As investors can see this chart is still in a relatively strong uptrend in spite of the recent oil price decline. However, the SPY has been showing a lot more weakness lately. It may possibly turn downward in the weeks and months to come. One critical event may be the January 22, 2015 ECB meeting. We are likely to hear whether Germany has acceded to the Draghi QE plan at that time. If Germany does accede to the plan, US equities could get some extra monies from EU investors. European investors would benefit from both a US equities rise and a USD rise. Each would be much more likely to occur if the EU was awash in an extra €1 trillion in liquidity.
Sometimes investors just have to wait on events to see what will happen. This is likely one of those times. A downturn (bear market) could be put off for another year or more, if the ECB QE plan is implemented. However, those expecting a lot of help for the US economy from low oil prices seem likely to be sorely disappointed. Certain industries may be helped; but overall the damage to the price structure and oil industries will be too dramatic not to be harmful to the US economy. The numbers support this argument well. The old adage that crashes lead to more crashes, also supports this thesis. Investors need to watch events closely. This is a critical time. It could be a time of injury to the markets; or it could be a time of dramatic injury to the markets. Only time and events will tell. The situation bears close scrutiny.
NOTE: Some of the above information is from Yahoo Finance.
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